Time to invest in longer duration funds: Dhawal Dalal, DSP BlackRock

Investors should not lock their investments and prefer high quality liquid assets instead of chasing higher return through illiquid assets.

My investment philosophy...

We follow a top-down approach while managing fixed income assets. We make investment decisions after studying a host of factors, such as macro-economic indicators, the RBI's monetary policy bias, government's fiscal policy, inflation trajectory in the near term, systemic liquidity in the banking system, current account deficit, and demand-supply dynamics in the bond currency market.

We also pay attention to global macro-economic developments and trends in the key commodity markets, which may have an impact on India's balance of payment mechanism in the medium term. These factors give us an indication on our likely position on the interest rate cycle.

My attitude to risk...

We believe that risks and returns are two sides of a coin and that it is not possible to generate a high return with low risk in the portfolio. We believe in incremental risk from the fixed income portfolio's perspective. So, before making an additional investment, we consider the incremental return we are likely to generate and the risk we are adding by purchasing an asset. If the risk-return trade-off is in investors' favour, we consider adding risk to the portfolio after a careful review of other relevant factors.

Investors should also ask a similar question while making an investment decision in fixed income schemes. A suitable question would be: how much incremental return will I be likely to generate over my investment horizon compared with that generated by liquid funds?

Since the latter are considered to offer low return at low risk, an investment in funds with higher risk should generate suitably higher returns than plain vanilla liquid funds. If the expected returns are not commensurate with higher risk, the decision should be re-evaluated.

My best & worst investment decisions...

We take investment decisions on behalf of our clients almost on a daily basis. This is done after a careful study of relevant factors and their expected outcomes in the near term based on the expected movement of key macro-economic variables and data points.

At times, however, the market may move in a different direction than the one anticipated by us while making the investment decision. The key is to recognise what is going on, reassess the thought process and reorient the portfolio strategy in light of any new development that has been overlooked or has been assigned lower probability.

My view on the debt market...

We expect the RBI to reduce interest rates by 25 basis points by May this year and then take a pause. Any reduction after that will be possible only if there is a sharp fall in headline inflation and current account deficit in the next six months. According to our current assessment based on the recent revision of diesel and electricity prices, as well as other factors, the headline inflation is likely to remain in the range of 7-8% in 2013.

The yield curve is likely to be steeper, with the short-term yields falling more than the long-term ones. This should result in the short- to medium-term assets faring well on risk-adjusted basis in the medium term. On the basis of our current assessment, the benchmark 10-year yield is likely to trade at 7.7-7.8% in the next three months.

My strategy for the debt market...

We are positioning our portfolios for a possible decline in interest rates in the near term. The government bond yield curve is likely to trend lower in the near term in response to the RBI's rate reduction. The short- and medium-term government bonds are likely to perform well on a risk-adjusted basis. We are looking to add more exposure at the right level in liquid government bonds.

As economic growth picks up steam, we are likely to see a higher supply of corporate bonds in 6-9 months. This should result in the widening of credit spreads over government bonds with similar maturities. Besides, the interest rate cycles in India are becoming shorter every year. So, it makes sense to concentrate on high quality corporate assets that are set to mature in 2-3 years. This should help investors earn a decent yield without too much interest rate risk.

The money market yield curve is likely to become steep in the near term as we expect a higher supply at the long end of the curve, while demand remains concentrated at the short end. We would like to add one-year bank certificate of deposit at 9.25% per annum.

My expectations from the Budget...

The bond market participants look for total government spending, fiscal deficit and gross budgeted borrowing for the next year. These set the tone for market expectations for the new supply pressure and, hence, are powerful triggers for the bond market movement.

This year is different and the finance minister has already indicated a continuance of austerity measures in the coming year. He has also provided the market with a possible path for the next couple of years to reduce the fiscal deficit and has exhibited a strong intent to adhere to it. So the focus of the Budget will be the revenue measures and their possible impact on systemic liquidity, current account deficit and inflation.

My advice to investors...

This may be a suitable time to invest in longer duration funds for those willing to take risks. However, investors should not lock their investments and prefer high quality liquid assets instead of chasing higher return through illiquid assets.